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In case of non current asset we distribute its cost over its useful life so to figure out exact profit or loss every accounting period through depreciation. And the expenses that we charge each year as depreciation is reducing the profit margin each year and by that much money we are maintaining a fund sort of being set in the cash balance which can be used for buying a new asset when the life of the existing asset expire . is this how depreciation helps in ensuring set up of fund for buying new asset and prevent extra impairment of capital
so is it basically charging depreciation we make sure to cut out a part of revenue as expense even thou is a non cash expenses so at the end of the life of asset we entirely recover the cost of the non current asset in our cash balance. did i understand right sir.
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The purpose of depreciation is to spread the cost over the useful life so as to match it with the revenue earned.
Buying a machine is an expense of running the business just as electricity is an expense. However, if the machine is going to last (say) 10 years and therefore earn revenue for 10 years, we spread the expense over 10 years by charging a bit of the expense each year – the depreciation.
I explain this, with examples, in my free lectures on depreciation.
The lectures are a complete free course for Paper F3 and cover everything needed to be able to pass the exam well.
but in that process of charging depreciation business also reserve fund right by lowering the profit which can be used later for buying new machine after the life of machine over in 10 years. basically i understood from ur lecture how depreciation works, but im eager to know that expenses charged as depreciation the cash stays in business only right which can be used for buying new 1 ones the whole cost of the previous machine recover by charging depreciation over its useful life, so that later on no further capital need to be introduced when it comes to buy the new machine after old machine expires
as u said we distribute the cost of asset over its useful life through depreciation. Its clear to me. My point is after charging depreciation it reduces the profit in st. of P/L . That much depreciation charged as expense is actually not going out as depreciation is non cash expenses, so it should be staying in business right and later on can be used for buying new 1.
I rather wanna confirm that does depreciation helps in recovering the cost of the asset thru this way or not and the money kept aside from revenue each year charging depreciation can business use that after the existing machine expire. this is my question. apart from this depreciation chapter i understood very well from ur lecture. Thank u sir.
I understand what you are saying, but charging depreciation does not in itself create a reserve fund in cash. How much cash they have available depends on how much they are spending, how much cash they are raising, and how much cash they choose to pay out as dividends. They may well choose to set some cash aside each year in order to save enough to replace assets, but they do not have to do that and charging depreciation does not mean that they are saving cash for it.
Think about what happens in Statement of Cash Flows (or if you have not yet got that far in the lectures, then think about it again when you do get to them 🙂 )
ok i got it so depreciation charging is a try to recover the expense of the asset over its useful life while it doesnt make sure actually cash balances will be there or not …… its clear to me now sir
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